Founded in Napoleonic times as a mining operation by an inventor of industrial scale zinc production, today’s Umicore SA (OTCPK:UMICF;OTCPK:UMICY) focuses primarily on the circular economy with a particular emphasis on the transportation sector. Umicore is a leading producer of catalysts for the use in passenger and light-duty vehicles and has a strong battery recycling division. In addition, the company also develops and produces batteries and surface treatment products which it collectively refers to as “Energy & Surface Technologies (E&ST)”.
After strong Full Year Results 2022, 2023 so far has been a challenging year for the company. The stock price decreased more than a third year to date. At these prices, I believe it to be an interesting opportunity as a long term investment. Below, I will explain my thesis.
Catalysis Will Remain Relevant For Quite Some Time
For the time being, the catalysis segment is Umicore’s most important business. As of H1, the division accounts for about 44 percent of adjusted EBITDA and 45 percent of revenue. The seemingly inevitable shift away from ICE vehicles will, naturally, lead to shrinking demand for catalysis going forward. However, as previously stated, I believe that for the foreseeable future, ICE vehicles will continue to play an important role at least in some markets. At the same time, increasingly stricter emissions regulations in many markets force manufacturers to continue to employ catalysis. An increasing share of hybrid vehicles (which tend to be favored by emissions regulations, especially in the EU) could be particularly beneficial for Umicore, as these offer both, an opportunity to sell a catalyst at the beginning of a vehicle’s life-cycle and the opportunity to recycle a battery a the end of it. Additionally, there may also be a growing market for catalysts for use in vehicles powered by hydrogen fuel cells going forward.
Battery Recycling Has The Potential To Grow Massively
Yet, while I believe the catalysis business to be far from being a “walking corpse”, the most interesting part of Umicore is its recycling arm. Even in a year with relatively weak commodity prices, this segment generates far higher profit margins than the catalysts ES&T businesses. As of H1, the division accounts for about 39 percent of adjusted EBITDA and roughly a quarter of total revenue.
The average life span of a car is somewhere around 300,000 kilometers which, depending on use intensity is typically somewhere between 12 and 20 years, give or take. Time will tell whether those figures will apply to BEVs in the same manner as ICE powered vehicles, but given that Tesla Inc. (TSLA) guarantees 120,000 to 200,000 kilometers of battery life (or 8 years, whatever comes first), I see some indication that the equation does not change too much (and if anything, the life of an EV will probably be shorter than that of an ICE, which in turn is a positive for a battery recycler).
The Tesla Model S, arguably the first commercially available BEV sold in relevant quantities, was introduced in 2012. So, we are probably only a few years away from relevant numbers of battery powered cars reaching the end of their (battery) life, thus becoming available for recycling. Also, with regard to hybrid vehicles, plug-ins have become more common in recent years. Plug-in hybrids tend to have larger batteries compared to other hybrids while the ICE component remains unchanged. Larger batteries, in turn, equal more recycling output per unit. While it is hard to predict an exact price range, I expect prices for materials thus recovered -namely Cobalt (LCO1:COM), Nickel (LN1:COM), Copper (HG1:COM) and Lithium (LC:COM) – to benefit from long term tailwinds given their importance for the transition away from fossil fuel energy.
There is also a strategic importance to recycling beyond environmental considerations, as it crucial to gain autonomy from (or at least reduce dependence on) the likes of China. Notably, China dominates the markets for several of the critical raw materials identified by the European Commission. Therefore, I would not rule out further incentives in the form of subsidies and/or recycling quotas in the future.
For these reasons, I think that Umicore, as a technology leader, is in an advantageous position to grow its recycling business
Relatively Healthy Balance Sheet
Umicore’s balance sheet, while not perfect, is at least relatively healthy. The company had cash and equivalents well in excess of €1 billion. As of June 30th, Umicore had net financial debt of €1.4 billion. That is around 1.5 times projected 2023 EBITDA (€960 to €1,020 million). This should enable the company to pay an annual dividend of €0.8 per share, in line with the previous year, for FY2023. An interim dividend of €0.25 has been paid in August. Umicore being a Belgian company, it should be noted that dividends are subject to a 30 percent withholding tax. I will, however, caveat that, going forward I do not expect increased dividends given the projected capex through 2026. Arguably, it might even be prudent and beneficial to long term shareholder value to temporarily reduce or cancel the dividend in order to further deleverage the balance sheet.
Risks and Downsides
Obviously, no investment is without risk. First, it should be noted that Umicore is a rather cyclical business. An economic downturn would hit the company at multiple fronts. Furthermore, battery production is the largest unknown in terms of future success. The E&ST segment accounts for 28 percent of revenue but more than two thirds of capex as of H1 (€335 million total capex for the period), despite cost sharing with joint venture partners such as Volkswagen AG (VLAKF;OTCPK:VWAGY;OTC:VLKPF;OTCPK:VWAPY). Despite significant investment, technological leadership is not guaranteed.
Conclusion and Valuation Target
All in all, I believe that Umicore offers more potential than currently priced in by the stock market. At the moment, the company trades at an earnings multiple of around 11. That is historically low. Given the strengths discussed above, I believe that a multiple of at least 15 to 17 would be more appropriate. That translates to a price target of €30 to €35 per share (roughly $32 to $37 at current exchange rates). For the ADR which represent a quarter share each, this results in a target price of $8 to $9.25. This represents an upside of 33 to 55 percent (share price at the time of writing: €22.54). Consequently, I view the stock of Umicore SA as a buy. One should, however, have a long term investment horizon and a reasonable amount of patience.
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